SARS gives some clarity on interest free loans - Grant Thornton

October 2008 Issue 08
By Hylton Cameron, Senior Manager, Grant Thornton Johannesburg
<strong>SARS</strong> <strong>gives</strong> <strong>some</strong> <strong>clarity</strong> on interest free loans
The Supreme Court of Appeal set “the cat amongst the pigeons” last year when it
ruled in the case of Commissioner for <strong>SARS</strong> v Brummeria Renaissance that an
accrual for income tax purposes took place in the hands of the recipient of an
interest free loan. Although it was understood that the case was decided on a
specific set of circumstances, it did cause serious apprehension in the tax fraternity.
The main concern stemmed from the interpretation that <strong>SARS</strong> would apply the ruling
in practice where inter-group interest free loans are the norm, rather than the
exception. <strong>SARS</strong> has now issued a draft interpretation note to address <strong>some</strong> of
these uncertainties.
The draft interpretation note issued by the Commissioner for <strong>SARS</strong> is aimed at clarifying the income
tax treatment where interest free (or low interest) loans are advanced in exchange for the receipt of
goods or services. While it mainly deals with interest free loans in a provided retirement village
example (where the developers essentially received an interest free loan in exchange for the
granting of life rights to the occupants of the properties), the draft interpretation note also provides
useful general guidance.
The Incidence of accruals in kind
The draft interpretation note makes it clear that an accrual
for income tax purposes only occurs in instances where
benefits in a form other than money are granted by one
party in exchange for goods or services supplied by
another party (i.e. there must be a quid pro quo).
Normal interest free inter-company loans will accordingly
not result in a tax incidence, unless the benefits of such
loans can be linked directly to the supply of goods or
services in exchange for such loans. In practice, in the
large majority of instances, there will be no direct and
identifiable benefit in the form of goods and services
accruing to the grantor of the loans. Interest free loans will
generally be part of the overall financing activities of a
group of companies linked to the overall treasury function.
The same principle will apply to interest free loans
between individuals. For example, no taxable amount will
accrue to a child on an interest free loan made to him / her
by a parent provided that there is no direct quid pro quo
linked to such interest free loan.

When does the accrual take place
The principle applied in the draft interpretation note is that the accrual takes place when the
barter transaction takes place (normally at the outset of a transaction). This approach is in line
with the normal principles of accrual, i.e. when a person becomes unconditionally entitled to an
amount.
How must the accrual be valued
Where the commercial benefit of the up-front accrual is utilised over a period of time (for example,
the utilisation of an interest free loan over a period of time), the valuation of such accrual
represents a significant practical challenge.
The draft interpretation note provides an example dealing with the retirement village scenario,
which sets out a barter transaction that consists of two elements that need to be valued. In the
first element, the developer receives an interest free loan for the remainder of the occupant’s life
span, and in the second, the developer’s right of use of the property is sterilised as long as the
interest free loan is in place. The value of the accrual in the hands of the developer will
accordingly be the net “profit”, or the difference between the value of the interest free loan and
the right of use of the property.
For the retirement village scenario, <strong>SARS</strong> uses the present value of the potential interest on the
interest free loan, discounted at the average prime interest rate in that year. This amount is then
reduced by the value of the usufruct in the underlying property (using the valuation rules
applicable to estate duty). In our opinion, this <strong>gives</strong> a fair valuation of the up-front accrual.
In other cases where valuation rules do not exist, it may be a significant challenge to identify and
value the various elements of a barter transaction. In this regard <strong>SARS</strong> has merely indicated that
each case must be evaluated on its own facts and merits. This is likely to result in disputes with
<strong>SARS</strong> in practice.
Other issues
The draft interpretation note indicates that certain categories of transactions may give rise to a
capital accrual in the hands of the various parties. We assume that this could potentially be in
cases where the right provided is of a capital nature (although this is difficult to comprehend in
practice). This is an issue where <strong>SARS</strong> needs to provide further <strong>clarity</strong>.
General binding ruling
Once final, the interpretation note will constitute a general binding ruling which will be effective
from the commencement of years of assessment ending on or after 31 December 2008.
A new era
The Brummeria case hailed a new era in income tax. It is now necessary to carefully identify and
value the various elements of barter transactions. Failing this, taxpayers will be left at the mercy
of <strong>SARS</strong> to value the amount of the accrual. The onus of disproving <strong>SARS</strong>’ valuation will rest with
the taxpayer.

For further information contact:
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